High Court Tightens Section 546(e) Safe Harbor for Securities Transaction Payments

In In re Argon Credit, LLC, 2019 WL 169315 (Bankr. N.D. Ill. Jan. 10, 2019), the U.S. Bankruptcy Court for the Northern District of Illinois ruled that, in accordance with section 510(a) of the Bankruptcy Code, a standby clause in a subordination agreement prevented a subordinated lender from conducting discovery concerning the senior lender’s claims. According to the court, the subordinated lender’s efforts to circumvent the clear terms of the subordination agreement by claiming that it was acting on behalf of the bankruptcy estate, or investigating the senior lender’s alleged fraud, were unavailing.

Enforceability of Subordination Agreements in Bankruptcy

If the claims of one creditor or group of creditors are subordinated in accordance with the provisions of a valid and enforceable agreement, section 510(a) of the Bankruptcy Code provides that the subordination agreement is enforceable in a bankruptcy case to the same extent that it would be enforceable under applicable nonbankruptcy law.

In construing the validity, enforceability, and application of a subordination agreement, section 510(a) directs the bankruptcy court to look to applicable nonbankruptcy law—generally state law—as well as the terms of the agreement itself. See Collier on Bankruptcy ¶ 510.03 (16th ed. 2019). If there is ambiguity in the agreement concerning the terms or extent of the subordination, a bankruptcy court may refuse to enforce it. See In re Bank of New England Corp., 364 F.3d 355, 367 (1st Cir. 2004) (remanding the case to the bankruptcy court to determine under New York law whether the subordination agreement actually provided for payment of postpetition interest on the senior debt prior to any payment on the junior debt), on remand, 404 B.R. 17 (Bankr. D. Mass. 2009) (finding that the parties did not intend to subordinate claims for postpetition interest), aff’d, 426 B.R. 1 (D. Mass. 2010), aff’d, 646 F.3d 90 (1st Cir. 2011).

Moreover, a chapter 11 plan need not necessarily give effect to the explicit terms of a subordination agreement in providing for the treatment of creditor claims. See In re Tribune Media Co., 587 B.R. 606, 614 (D. Del. 2018) (because section 510(a) is expressly excepted from section 1129(b)(1) of the Bankruptcy Code, a nonconsensual chapter 11 plan that does not fully enforce a subordination agreement may be confirmed so long as "the plan does not discriminate unfairly, and is fair and equitable").

Argon Credit

Argon Credit, LLC, and Argon X, LLC (collectively, "Argon") operated an online lending platform providing near-prime consumer installment loans. To fund its operations, Argon borrowed $20 million in 2015 under a senior secured revolving credit facility. The debt was subsequently assigned to another lender (the "Senior Lender"), which subsequently increased the funds available under the revolving facility to $37.5 million (the "Senior Debt").

Certain Argon equity holders (collectively, the "Junior Lender") also made loans to Argon in 2015 (the "Junior Debt") on a subordinated basis. The subordination agreement and certain subsequent subordination agreements (collectively, the "subordination agreement") entered into by the Junior Lender and the Senior Lender provided for a "standby limitation" as follows:

Notwithstanding any breach of default by [Argon] . . . under the [Junior Debt agreement], the [Junior Lender] shall not at any time or in any manner foreclose upon, take possession of, or attempt to realize on any Collateral, or proceed in any way to enforce any claims it has or may have against [Argon] or any other Obligor unless and until the Obligations to the Senior Lender have been fully and indefeasibly paid and satisfied in full.

In 2016, Argon filed a chapter 11 case in the Northern District of Illinois. After converting the case to a chapter 7 liquidation, the bankruptcy court approved a stipulation (the "discovery stipulation") between the chapter 7 trustee and the Senior Lender coordinating discovery by the trustee and all "parties in interest" under Rule 2004 of the Federal Rules of Bankruptcy Procedure regarding the enforceability of the Senior Debt. In accordance with the stipulation, all discovery requests were initiated in the first instance by the trustee, unless a party in interest conferred in good faith with the trustee concerning requested discovery and the trustee elected not to pursue the request, in which case the party seeking discovery could request it directly without filing a separate motion for court approval under Bankruptcy Rule 2004.

The trustee sought discovery from the Senior Lender of various documents related to the Senior Debt. The Senior Lender moved to quash the subpoena. The Junior Lender objected and (with the trustee’s approval) sought an order from the bankruptcy court enforcing the subpoena.

The Senior Lender argued that the standby clause in the subordination agreement precluded the Junior Lender from seeking the requested discovery. The Junior Lender countered, among other things, that the subordination agreement did not bar it from obtaining discovery: (i) on behalf of the trustee and/or the estate; or (ii) regarding the Senior Lender’s alleged fraud in inducing Argon to incur the Senior Debt.

The Bankruptcy Court’s Ruling

The bankruptcy court found that the standby clause in the subordination agreement was "an explicit and express ‘silent seconds’ provision aimed at preventing ‘obstructionist behavior’ [and] it [went] above and beyond the mere maintenance of the ‘hierarchy of lien priorities’" in a subordination agreement (citing In re MPM Silicones, L.L.C., 2019 WL 121003, at *11 (S.D.N.Y. Jan. 4, 2019)). According to the court, the clause prevented the Junior Lender "from using the bankruptcy process to affirmatively obtain discovery" from the Senior Lender regarding the Senior Debt.

Specifically, the court ruled that the Junior Lender could rely on neither the discovery stipulation nor Bankruptcy Rule 2004 to obtain discovery against the Senior Lender. The plain text of the subordination agreement, the court wrote, prevents the Junior Lender "from proceed[ing] in any way to enforce any claims" against the Senior Lender. According to the court, any act by the Junior Lender to obtain discovery concerning the Senior Debt "is a calculated, if intermediate, act to enforce" its claims against Argon. "It simply cannot be assumed," the court wrote, "that [the Junior Lender] is asking for discovery for no reason; [it] cannot be presumed [to be] irrational."

The bankruptcy court rejected the Junior Lender’s argument that it was seeking discovery on behalf of the estate with the trustee’s consent. Although the Junior Lender did coordinate its discovery requests with the trustee, the court explained, the trustee informed the Junior Lender that the estate could not afford to press forward with discovery demands after the Senior Lender refused the trustee’s initial request for documents but did not oppose the Junior Lender’s efforts to pursue further discovery. Nor did the trustee request that the Junior Lender perform duties on behalf of the trustee or the estate.

The court also rejected the Junior Lender’s argument that the discovery stipulation somehow amended or waived the standby clause. According to the court, there was no clear indication that the Senior Lender, by entering into the discovery stipulation, either: (i) assented to a modification or amendment of the subordination agreement; or (ii) intentionally relinquished its rights under the subordination agreement, which generally benefited many parties in interest, not merely the Junior Lender.

Finally, the bankruptcy court was unpersuaded by the Junior Lender’s argument that it should be allowed to investigate whether the Senior Lender fraudulently induced Argon to enter into the secured credit facility and the related subordination agreement by promising a $75 million line of credit that the Senior Lender never intended to provide. According to the court, Delaware law (which governed) does not permit nonenforcement of a bargained-for agreement between sophisticated commercial actors whenever one party claims that fraud has occurred. In addition, although a subordination agreement may be rescinded under certain circumstances as a remedy under Delaware law, the Junior Lender was not seeking rescission in this case. Thus, the subordination agreement would be enforced in Argon’s bankruptcy case until a court ruled otherwise in an appropriate proceeding. In such a proceeding, the court wrote, the Junior Lender might be entitled to discovery from the Senior Lender "under the ordinary civil rules."


The court’s ruling in Argon Credit indicates that, absent ambiguity or some other infirmity in a subordination agreement, a bankruptcy court will enforce the agreement in accordance with section 510(a) of the Bankruptcy Code. The bankruptcy court in Argon Credit foreclosed the Junior Lender from performing what the court perceived to be an end run around the express terms of the subordination agreement. As noted, however, the court did not rule out the possibility that the Junior Lender could obtain discovery in separate litigation over the enforceability of the subordination agreement.

Interestingly, in a footnote, the bankruptcy court noted that the Junior Lender’s equity interest in Argon did not confer "party in interest" status on the Junior Lender independently of its claim based upon the Junior Debt because it had "no ‘legally protected interest’ based on the equity interest[] alone absent a showing of a possibility of a surplus estate" (citation omitted). Moreover, because the Junior Lender did not raise the argument, the court declined to consider whether its status as an equity interest holder made it a party in interest for purposes of the discovery stipulation. Had Argon’s case not been converted to chapter 7 or had the estate had a surplus, this might have been a more significant issue. See 11 U.S.C. § 1109(b) (defining "party in interest" in a chapter 11 case to include "an equity security holder").

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